Economic recovery delayed but not derailed

The second half of summer has seen its share of data disappointments while rising COVID cases add another layer of concern, but central banks appear to be taking these developments in stride. Fed Chair Powell didn’t make waves with his late-August speech at Jackson Hole but he continued to guide markets toward a 2021 taper. Even with a lacklustre jobs report since then, we think the Fed has enough evidence of labour market recovery to begin easing off the QE pedal later this year. Australia’s lockdowns failed to deter the RBA from tapering its asset purchases in September, with the central bank saying the Delta outbreak will “delay, but not derail the recovery.” The Bank of Canada didn’t sound overly concerned about unexpected GDP declines, saying it continues to expect the recovery will strengthen over the second half of the year. Another month of solid job growth in August seemed to support that view. The ECB also announced it would slow its bond buying in September, while the BoE is on track to finish its QE purchases by year end.

While policymakers aren’t overreacting to a few data points, we’re seeing strong enough headwinds to mark down our growth forecasts in Canada and the US. Supply chain issues, labour shortages and mismatches, and in some cases delayed reopening due to the Delta variant are making it difficult to sustain the recovery’s brisk early pace. But we agree with the general message from central banks—these factors won’t derail the recovery. We continue to expect modest rate hikes from the Fed, BoC and BoE next year, while the ECB and RBA aren’t as close to liftoff and will continue with dialed-back QE in 2022. Our base case is for gradual policy tightening with financial conditions remaining broadly accommodative over our forecast horizon. But central banks will be data dependent, and elevated inflation rates and uncertainty about the persistence of price pressures continues to raise the risk that interest rates will have to rise faster than many anticipate.

Highlights:

• Recent indicators of US consumer spending and job growth have been on the softer side, trimming our near-term growth forecasts. That said, we continue to expect healthy GDP and job gains that should convince the Fed to taper its QE program by year end.
• Canadian GDP data surprised to the downside though labour market indicators are more in line with a re-opening driven recovery over the summer. The Bank of Canada didn’t sound overly concerned in September but will likely have to revise its growth forecasts lower in late-October.
• The UK economy is losing its early reopening momentum though improving labour market conditions should leave the BoE on track to wind down QE later this year and modestly raise interest rates in 2022.
• The euro area’s reopening was slightly delayed but that’s meant more recovery momentum over the summer. The ECB reduced the pace of bond purchases in September but will continue to rely on QE throughout 2022 and rate hikes remain a distant prospect.
• While Australia’s economy is in the midst of a lockdown-driven Q3 contraction, the RBA followed through on its guidance to slightly reduce the pace of QE in September.

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Josh Nye is a senior economist at RBC. His focus is on macroeconomic outlook and monetary policy in Canada and the United States. His comments on economic data and policy developments provide valuable insights to clients and colleagues, and are often featured in the media.

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